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Exchange of debt for equity

This guidance applies to periods of account beginning before 1 January 2005

Where a borrower is in difficulties, a creditor may take shares in the borrower instead of a repayment. This is usually called a debt/equity swap, and may be part of a corporate rescue.

»Ê¹ÚÌåÓýapp value of the shares may be less than the amount of debt outstanding, but as part of the arrangement the creditor discharges all liabilities.

For example, JH Ltd lends £100,000 to KF Ltd. KF Ltd gets into difficulties and JH Ltd agrees to accept 500 x £1 shares in full and final settlement of the debt. Because of the poor state of KF Ltd, these shares are only worth £1,000.

»Ê¹ÚÌåÓýapp treatment for accounting periods starting before 1 January 2005 was very similar to the current rules. If the companies were not connected, before or after the debt/equity swap, the creditor could have relief for the amount released (£99,000 in the above example) under the authorised arrangements for bad debt. If the companies were connected - including becoming connected simply because of the exchange - FA96/SCH9/PARA6 would have applied to disallow relief. For example, the creditor could acquire a controlling shareholding in the debtor company because of the swap.

This might have discouraged rescues from taking place, so FA96/SCH9/PARA6(4) and FA96/SCH9/PARA6(5) allowed limited bad debt relief where the creditor satisfied certain conditions.

Current guidance in this area can be read at CFM35370 onwards.